The New York Stock Exchange’s S&P 500 index is up 50% in the last two years. According to the New York Times this week, the stock market is in a similar moment to 29 years ago, when former Federal Reserve Chairman Alan Greenspan warned that a “irrational exuberance” has inflated a bubble in Internet company stocks (Dotcom bubble). The S&P 500 had risen more than 60% in the years before the speech Teacherin December 1996.
The Times is not the first to make this comparison. It won’t be the last time either. The Bank of England recently warned that valuations of US stocks are reaching levels not seen since. Also the former number two of the IMF Gita Gopinath warned of a possible stock market crash in a recent article in The Economist.
There is an index that measures this fear. It is called P/E (from English). Price-earnings ratio) and measures how often the current price of a stock exceeds the annual net profit or, in other words, how many years of a company’s profit are required to recover the money invested in purchasing the stock, assuming that profit remains constant. An example is: If the index is 10, that means investors are paying 10 times the company’s annual earnings for each share A person who buys this stock will take 10 years to get the money back if profits are constant during the period.
The S&P 500 index’s P/E ratio is higher than usual today, as the New York Times noted last week. Over the past decade, the ratio has averaged 22. Now it’s close to 30, the same level it reached in 1999 during the dot-com bubble.
That episode consisted of the decline of the Internet companies that led the rise of Wall Street stocks in the late 1990s after their balance sheets showed they weren’t making as much money as they thought. When the bubble burst in March 2000, Cisco Systems was the largest company in the S&P 500. Its P/E ratio reached 200.
Today, Nvidia, the largest company in the S&P 500 and the first company to reach a valuation of $5 billion on the New York Stock Exchange, is also experiencing extreme valuations. In 2023, the P/E ratio reached the same level as Cisco’s.
Nvidia stock is up 1,000% in the last three years (from $17 to $180), but its profits have risen even faster. This means the stock is cheaper than before.
When Greenspan issued this warning, the dot-com bubble did not burst but continued to grow. In fact, the S&P 500 rose more than 100% before peaking in March 2000. He then fell two years in a row, returning to the same level he was at when Greenspan gave his speech.
Some investors fear that we could be living in a time similar to 1999, just before the crash. Many companies turn out to be not so profitable and resort to debt to finance their losses. Oracle’s shares fell 11% this Thursday, raising doubts about its commitment as an OpenAI provider. A report from the Massachusetts Institute of Technology (MIT) found that 95% of a survey of companies saw no benefit from their AI initiatives. This suggests that AI has not yet shown enough impact to increase the overall productivity of the economy. AND Michael BurryThe investor, celebrated for his predictions of the 2008 financial crisis, recently compared Nvidia’s role to that of Cisco during the dot-com boom and described OpenAI as the next Netscape, one of the first Internet search engines in the mid-1990s: “convicted and lost money.”
What are the differences between then and now?
Greenspan raised the rate three times between late 1999 and 2000. to reach 6.5%, the highest level in 25 years. After the crash, he lowered it to 1% within two years.
Today, however, the Federal Reserve is on a different path (for now).: This week Jerome Powell cut the interest rate again by a quarter point and it is at a lower level than in 2000 (3.5%-3.75%). Everything indicates that the rate will not fall any further. But it appears to be far from starting an upward trend like it did in the 2000s.
Furthermore, there will be bubbles, but all the billions of dollars invested will still lead to productivity gains in the economy.
“Is it a bubble?” Howard Marks, co-president of Oaktree Capital Management, asked all things artificial intelligence investing on his podcast this week. Marks returns to the Times comparison by citing Alan Greenspan’s expression of “irrational exuberance.” “There is no doubt that investors are irrationally exuberant about AI. The question is whether it is irrational. Given the enormous potential of AI, but also the large number of unknowns, I think that hardly anyone can make a certain statement. Bubbles are best identified with hindsight.”
About The Author
